Protecting Your Business: Restrictive Covenants
Written by Commercial Dispute Resolution Team | 19th December 2021
The economic impact of the recent lockdowns has made for an unusually challenging last 18 months. Businesses and workers have had to adapt, with companies evolving their revenues streams and many employers changing sectors. In the face of this upheaval, and certainly, with the coming to an end of the government’s furlough scheme, it is important for businesses to remain savvy to the options open to them in protecting themselves.
An important tool in their arsenal is the restrictive covenant.
What are restrictive covenants?
Restrictive covenants, as the name suggests, are a promise given by a person not to do something. Restrictive covenants in an employment or service contract, are promises given by employees or workers (or even directors of a company) not to do something after their employment/engagement comes to an end.
It is important to note that restrictive covenants do not exist more broadly in law. This is to say that, unless they are agreed with the employee typically has a term within their employment or service contract, that they cannot be relied upon. For example, there is no restriction on an employee going to work for a competitor, unless he or she has expressly agreed not to.
There are two main approaches for recovering unpaid invoices (which are classed as a debt); either through instigating court proceedings or through seeking bankruptcy or winding up of the debtor. Both procedures can be instigated against businesses and individuals, however, there are procedural differences depending on which one is the other party.
Why are restrictive covenants important?
Restrictive covenants can be vitally important in protecting a range of business interests that are otherwise afforded no protection. The value of these restrictions will vary from business to business and will depend upon the nature of its services and the position of the employee/workers. However, it is always worth evaluating your own interests and how these are being or should be protected. By way of example, some common restrictions deal with the following. An employee or worker leaves the business and then –
sets up in competition or with a competitor;
approaches the employees of his former employer to come and work with him;
approaches that businesses clients for work;
provides work for the businesses clients through his new employer.
All these are fairly common scenarios presenting a risk to businesses, through loss of staff, revenue or reputation. To what extent is your business protected in these scenarios?
Properly worded restrictive covenants can address each of the above and go some way to protecting your businesses interests.
What can we do?
The first step should always be to consider carefully what the business wishes to protect. The “knowledge” of the company? The equipment? The staff? A list of suppliers who provide the best prices? Details of deals? Are production methods specific to the company? Details of the negotiations for the new premises? These can all be included in a well-written employment or service contract, which, alongside appropriate “confidentiality” provisions, strengthens a company’s legal position.
However, it is important that restrictive covenants are correctly thought through and worded properly. By definition, their effect is to restrict trade, which is against public policy and generally unlawful. A restrictive covenant is only valid at law insofar as it does no more than protect a legitimate business interest. In practice, this means that the following should be considered in respect of each restriction: –
Is it necessary? Is the interest which is being protect already protected elsewhere? For example, if the risk being protected is the risk that an employee will take client pricing lists with him, is this already protected by confidential information provisions stated elsewhere in a contract?
Is the restriction too wide? This means making sure that the restriction is doing no more than protecting a business interest. For example, if the concern is the risk that an employee goes to work for a competitor down the road, it would make little sense for the restriction to prevent the employee working for a competitor in another part of the country.
Is the restriction too long? Any restriction which is not limited in time will be invalid and should only last as long as necessary in protecting the business interest. This period will really depend on the interest being protected but anything longer than 12 months is unlikely to be held as lawful.
Common scenario
Restrictive covenants often come into play in scenarios where employees who leave a company to set up a business themselves and approach the current employees to poach them; or compete with the company using the company’s resources, gained through their employment. This is, sadly, more commonplace than you would expect. Without a contract with the appropriate restrictive covenants in place, a company will have very limited options to stop the employees from misusing the information.
A contract clearly setting out these obligations and restrictions, and, signed by employees, creates a solid advantage for business owners if there is a breach of contract by the employees during or after their employment. It is easier to take action on something that has been set out and agreed between the parties than struggling to prove that there has been a breach because there is no contract in place, or the contract does not have restrictive covenants.
What happens if an employee or worker does not comply with a restriction?
If an employee or worker puts themselves in breach of a restrictive covenant then this will amount to a breach of their employment/service contract. In such a scenario, two main options will likely be available.
Firstly, the business may apply to the court for an injunction, preventing the employee’s continued breach of the restriction. The value in this is really to prevent further damage. If, for example, the employee has already approached employees or made contact with clients, an injunction is unlikely to have any practical effect.
Secondly, the business may claim against the employee for damages, representing the financial losses to the business caused by the breaches. In practice, this may be the value of lost business caused by the employee having poached work or clients.
These options can be taken forward together and the best approach will depend on the nature of the breaches and the impact they have on your business.
In Summary
Having well-drafted employment or service contracts in place, reflecting what the company wishes to protect, can be very valuable to a business and may save on time and costs in the long run.
It is important for businesses to routinely review the interests that need protection to ensure that their contracts and restrictions are up to date. For the reasons set out above, having out of date restrictions can make them unenforceable as they may be seeking to do something which is no longer limited to the businesses current business interests.
Can we help?
Should you wish to discuss how your business needs can be protected or wish to discuss the content of your existing contracts, we would be happy to assist.
Speak to a Restrictive Covenants Solicitor
You can call Ceren Fox from Commercial Disputes on 01752827120 or email her on cfox@nash.co.uk
